One-time United States Federal Reserve board member Randy Kroszner has no regrets about the decision to slash rates and implement quantitative easing during the global financial crisis, but he warns the era of all-powerful central banks is over.
Central bankers of the world made the right call when they responded to a great market crisis with record-low interest rates and unprecedented levels of artificial liquidity a decade ago; however, today those tools have lost most of their power.
Structural reforms must take over where central bank meddling left off, and some of US President Donald Trump’s plans to reduce the tax and regulatory burden on business could help.
That is the view of University of Chicago Booth School of Business professor Randy Kroszner, who served as a member of the Board of Governors of the US Federal Reserve from March 2006 to January 2009 and was chair of the central bank’s Committee on Supervisory and Regulatory Affairs during the global financial crisis (GFC).
At its September policy meeting, the Fed voted to start reducing its $US4.5 trillion ($5.65 trillion) balance sheet from October, while holding rates in the range of 1 per cent to 1.25 per cent.
Kroszner said the decision made good sense.
“This ‘great unwind’ of quantitative easing so far has not caused any great tumult in markets,” he said. “This should help the European Central Bank start to move to end its asset purchase program and central banks around the world to gradually normalise their balance sheets.”
Kroszner says he has no doubt the swift actions the Fed took in 2007 and 2008, and the co-ordinated response from global central banks that followed, were effective in averting deflation or another great depression.
“Part of the reason for the central bank making asset purchases was to avoid the negative impacts that occurred in the early 1930s,” Kroszner says. “In hindsight, these measures did give people greater incentive to take on more risk.”
But he cautions that with the Fed and the European Central Bank now focused on winding down their balance sheets, it is important to remember that artifical liquidity measures “aren’t the only game in town” for driving economic growth.
Kroszner is worried that too many nations remain slow to tackle structural reforms needed to allow for more competitive markets.
He argues that while easing monetary policy was necessary to avoid deflation, central bankers’ time in the sun is now over and policymakers must step in with fiscal reforms to promote innovation and investment, and revive economic growth.
Kroszner spoke to Investment Magazine ahead of a planned visit to Australia to deliver a keynote address on the topic of ‘Trumponomics’ to the 2017 CFA Australia Conference, to be held in Melbourne on November 1.
Another decade till normal
After 10 years of loose monetary policy, low rates now provide less stimulus and more side-effects. Kroszner says “the jury is still out” on the question of whether quantitative easing has inflated an asset bubble in US real estate and equities that will end in tears. Nevertheless, he warns it is now time to try a different approach to stimulus.
“The concept of using fiscal policy to fine-tune the economy went out of style around the time when economists were trying to work out why real interest rates were unusually high, so perhaps it is time to dust that idea down,” Kroszner says.
Despite some healthy job gains, which should be accelerating wages growth and, in turn, forcing companies to raise prices to maintain profits, inflation in the US has been running lower than expected this year.
Given that inflation expectations can take a long time to adjust fully to a new target, Kroszner says US Federal Reserve chair Janet Yellen’s “cautious optimism” the bank is on track to its 2 per cent inflation goal seems justified. He tips it will take about another decade to see US monetary policy back within a “normal” realm.
With the US having been the first to raise rates, Kroszner expects it will also be the first major economy to return its balance sheet close to normal levels – within three to four years – with other countries, notably China, likely to take much longer.
Return to fundamentals
Instead of fixating on what the central banks will be doing, Kroszner urges chief investment officers and their portfolio managers to think about which other long-run economic fundamentals – such as efficiency-enhancing structural reforms – are going to influence markets positively in the future.
It is still early days, but Kroszner’s encouraged by structural reforms that have started to revive growth in southern European countries like Spain, and expects Italy, which has been a laggard on reform, to follow suit eventually. What happens in China will be key.
Structural reforms he expects to help restore growth to the US include the harmonisation of occupational licensing between state jurisdictions. He also expects the removal of disproportionate regulatory and compliance burdens, to make it easier for workers to move into areas where there’s higher demand, while allowing new market entrants to compete.
In the US, Trumponomics has so far failed to deliver its promised regulatory reforms and lower tax rates, but Kroszner believes this structural reform agenda remains a clear priority for the US Congress.
Despite Trump not being able to roll out his pro-business agenda as quickly as promised, his presidency has boosted market optimism, Kroszner says. “Some cabinet secretaries within the Trump administration have managed to make [small] regulatory changes, and this has signaled to the market that things are at least moving in the right direction.”
Editor’s note: This article was produced prior to US President Trump announcing his intended sweeping new tax reforms in late September, including a plan to cut the corporate tax rate to 20 per cent.
Showing no fear
Overall, Kroszner believes the world economy is better placed today to handle future shocks than it was before the GFC. This is in large part a credit to better corporate risk management and the improved liquidity of major banks, he says.
“This clearly depends on the nature of future shocks but, generally speaking, we’re better placed to handle them going forward.”
What does worry Kroszner is eerily low volatility levels, as evidenced by the CBOE Volatility Index (VIX) – aka the ‘Fear Index’.
In late September, despite rising geopolitical risk amid North Korea’s aggressive posturing, this measure was sitting at about 10, way off its intra-day high of 89.53 in October 2008. It concerns Kroszner that geo-political and other political risks appear to be of so little concern to the market.
“Admittedly, we’ve seen reasonably good growth throughout the world, so the Fear Index should not be as elevated as it was back then,” he says. “But synchronised global growth since the GFC may have given the [false] impression that future shocks can easily be absorbed.”